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Anyone can invest in this above average hedge fund

Hedge funds, bastions of wealth, accessible to the rich and famous and well connected. These purported money machines are so sophisticated that they're off limits to anyone who isn't an accredited investor, supposedly someone who's wealthy enough that they know how to not lose money. The truth is much different from the myth, most hedge funds, like most mutual funds do poorly. In aggregate hedge funds and mutual funds are the market, it's impossible for all of them to outperform. The largest ones have managers who are constantly in the news promoting their views. Who in finance doesn't know who David Einhorn, Bill Ackman, or Carl Icahn are?

I'm guessing all my readers are familiar with hedge funds, and most probably work at one, but not many can actually invest in one, let alone one with a record of outperformance. Of course all my hedge fund readers work at outperforming funds, you're all headquartered in Lake Wobegon right? There actually are many funds that outperform each year, and some outperform for decades. Most of these funds fly under the radar and away from the news. Most are not household names like the company in this post.

The selling point for a hedge fund is an investor is gaining access to a vehicle that has the ability to outperform the market through going long and short stocks with a judicious amount of leverage. To gain access to such a dream machine investors pay steep fees upwards with the standard being a 2% management fee and 20% of profits going to the fund. In theory the fund will do well enough after fees that the gross fee amount doesn't matter. This is certainly true for some funds, but others don't do well enough to justify their fees.

Senvest Capital (SEC.TO, SVCTF) is an asset manager based in Montreal Quebec. The company started off as a manufacturer of electronic theft systems, listing on the TSX in 1971. Starting in the 1980s and into the 1990s the company morphed from being an electronics company to a holding company for various investments. Management realized that they were better at understanding business and allocating capital than running an electronics company.

From the early 90s to 1997 the company primarily invested capital through their New York subsidiary. In 1997 they launched their first limited partnership, Senvest Partners. Again in 2003 the company seeded a partnership, Senvest Israel Partners. The funds have done well, Barrons noted in 2011 that Senvest Partners was the best performing long-short fund over the 2008-2010 time period. Bloomberg cited Senvest Israel as the best performing fund for the five year period ending February 28th 2011. In a world with thousands of hedge funds remarks like this are significant.

Senvest Capital is a bit of an oddball stock. Senvest Capital is the asset manager that owns Senvest Partners and Senvest Israel along with a grab bag of other assets. If this company simply were an asset manager with some outside holdings they wouldn't be any more interesting than any of the dozens of other public asset managers. The difference is that a large part of Senvest Capital's holdings are in their own funds, and that investors can buy these assets at a significant discount.

Here are the company's assets from their latest annual report:

The three biggest items on the balance sheet are their investments, their investments in their hedge funds (investments in associates), and some miscellaneous real estate investments. The company has almost no liabilities, they amount to $95m and consist mostly of liabilities related to equities sold short.

The company isn't exactly transparent when it comes to explaining their own investments. They make the following disclosure:

The company has $184m in listed securities and $32m in unlisted securities. The notes explain that the unlisted securities are positions in private companies that have no public market. Inquiring minds are probably dying to know what securities the company holds in their listed portfolio. Unfortunately the notes in the annual report don't reveal anything, but there is a way to get a peek. Senvest manages their money through a subsidiary in New York. The subsidiary in New York is required to file their holdings with the SEC regularly. While the filing doesn't disclose all of their holdings it does give a good picture as to what they hold. The link to those filings is here.

Some of the unlisted holdings are non-traded REITs, and shares in non-public banks.

What makes this investment so interesting is how cheap the holding company is, and how well they've performed over the years. The company is trading at a discount to NCAV, a significant discount. Shares last traded at C$81.85 against a book value of C$117.50. A friend who is very familiar with this stock estimates that book value is above $120 p/s currently.

It's almost strange that the management company of outstanding hedge funds would trade at 2/3 of BV. What's even more incredible is that book value consists of mostly liquid investments, equity securities, stakes in hedge funds, and some illiquid real estate investments. What I find even more incredible is that Senvest as a company has a history of providing solid returns, this isn't a one time undervalue of a mediocre money manager. I have a table showing book value and earnings per share back to 2004 below:

From 2004 to 2012 the company grew book value from $22 to $117, that's a compound growth rate of 22.8%. The company's funds have performed similarly over the same period of time.

Readers will note that earnings per share are very volatile. The company earns a revenue stream from fees associated with the funds. Unfortunately the fund fees don't cover all of the company's operating expenses meaning the difference ($10m) is made up from equity holding gains. Given the company's investment performance over the past eight years making up this shortfall hasn't been an issue. In years when their company's investments do poorly their earnings take a significant hit, like in 2011. In years when their investments do well earnings do well too, like in 2012. The company is trading for a P/E of 3x, although I'm not sure earnings are the best way to value the company.

I've explained the math in the past on investing in companies below book value that are consistently growing book value. Using this math an investor today buying at 2/3 of BV with the company's 22.8% growth rate is actually earning a 34.5% return on their investment if the future looks somewhat close to the past.

Investing in Senvest Capital isn't a normal value investment, it's more of a mutual fund, value stock, and hedge fund hybrid investment. An investor gets the chance to own pieces of Senvest's mutual funds, along with some of their private investments, all at a 2/3 discount. Along with this the common equity investor pays no fees, rather they are a beneficiary of the fees that the company's fund investors pay. Even with all these things investors are still provided a margin of safety, they're buying at 2/3 of a very tangible and liquid book value.

23 comments:

The latest financials show investor money (ie redeemable units) in more detail.

For example total assets were 454MM 12/31 are now shown (restated) as 728MM. The increase of 273MM is offset by redeemable partner units of 190MM as well as additional items such as money due to brokers. The shareholder equity did not change at 358.8MM as of 12/31/2012.

Thanks Nate, this is a real gem. I found it interesting that insiders own 55% of the shares, mostly the Mashaal family. So interests should be aligned with shareholders.

As far as prospective return though, I believe you're ultimately going to do as well as Senvest investments do. Historically, although I haven't looked too closely, it appears there is usually a gap between the NCAV & market price.

Also, 23% annual returns are insane, I don't believe even Warren Buffett can match that. But achieving 15% annual returns going forward would make shareholders very wealthy indeed. I can't wait to do further due diligence on this one.

I agree with you that the return comes from investment performance not a closing of the discount gap. The funds have done well and it appears that they're investing the firms capital in a similar manner. These guys are just so secretive and off the beaten path.

The returns are crazy, you're correct on the insiders, I forgot to mention that.

any guess why they're not buying back stock here? If I were them I'd be buying stock with my own money in the open market as well as taking whatever cash was available to buy back stock, maybe even sell some stuff to do so.

any thoughts on how they've treated minority shareholders in the past also to judge their respect for those of us along for the ride?

In the past, they did buy back stock. You can go onto SEDAR and look up their old annual reports and MD&As, which contain some cool commentary.

Their stock currently isn't very liquid so they can't buy back many shares even if they wanted to. I get the feeling that they aren't super interested in buying back shares (kinda like how Buffett isn't a fan of buying back Berkshire); Senvest could certainly be a lot more aggressive about share repurchases. One of their major holders has been selling and they could do a tender offer or buy back those shares in a privately negotiated deal or something like that.

I'm afraid the annual returns of 22.8% to book value aren't true though. In 2005 the accounting rules changed which is why there was a huge increase in book value. It wasn't a gain so much as revaluing all their assets to fair value and realising lots of historical gains. I did a brief post on it here http://investingsidekick.com/hedge-fund-at-a-discount/

If you look at the returns since 2005 it's only 12.7% per annum. Still decent though.

At around 2004/2005, I believe they started marking their stocks to market. So you need to adjust for that when handling book value / share calculations. I would retroactively mark everything to market.

There is also something with options expense that I don't understand. They stopped issuing options in 2005, but they are expensed now or something (???).

If you gave out any more advice on them you would probably have to charge them a consultant's fee. Thank you for sharing the information with us. You are right about the difficulty associated with finding a hedge fund that performs really well.

I am concerned about the level of transparency shown by the company. They could be more open with all the details.

- As stated in the management proxy, common equity investors do pay fees as there is a management bonus pool of 3.5% on pre-tax income and up to a further 3.5% if they exceed their benchmark by 35%. There are other employee expenses outside the bonus pools.- The proxy also points out that the company only owns 60% of the revenue generated by the asset management company, with the other 40% going to Richard Mashaal. So the company is paying fees on its investments in the funds since it doesn't fully own the asset manager. The funds have a 1.5% base fee with 20% performance fee (with high watermark).

So considering this, there is a cost, although when factored in, it's less than what investors in the funds would pay and is also further offset by the discount to book. If they can grow the outside AUM considerably, then maybe the 60% interest in the asset manager could have some meaningful value, although for now it looks like this just helps offset the cost of the management bonus pool in the holding company.

Hopefully these guys will use the buyback authorization aggressively - it is easy to create value buying back your own shares at a 38% discount (discount is probably higher since they are net long and market has increased since 6/30).

There was a pretty interesting writeup on SA about this company today. The author thinks that the fee-based asset management business is potentially worth more than the liquid NAV. http://seekingalpha.com/article/1759562-senvest-capital-40-discount-to-nav-with-a-significant-near-term-catalyst

Just wondering whether Senvest Capital pays the 1.5/20 fee to the funds (senvest master fund and senvest israel) for the capital it invests in these two funds. I have not been able to find details on this in the annual.